Types, Features, and Taxation of Trusts Flashcards
(56 cards)
1
Q
What is a trust?
A
- A separate legal entity that allows a person (a grantor or trustor) to transfer assets to another person (the trustee) for the benefit of the bene’s
2
Q
Explain the parties in a trust
A
- Grantor
- The one who establishes the trust and funds the trust
- Can also be trustee and bene (if revocable trust)
- Trustee
- Responisble for managing trust assets and fullfilling instructions outlined the trust document
- Considered a fudiciary
- Bene
- Hold beneficial interest in trust assets and/or trust income
3
Q
What are some reasons of using a trust?
A
- Avoid probate
- Reduce gross estate
- Assist those who are not capable of property management
- Creditor protection
- Spendthrift clasue can be included so that bene’s cannot assign, pledge, or promise to give assets of the trust to anyone
- Can allow trustee to make distributions on a discretionary basis
- Can split interests in property
- Avoid taxes due to future appreciation
- Avoid transfer tax on subsequent generations
NOT ONE SINGLE TRUSTS CAN DO ALL OF THESE, so financial planner must use different kinds for different situations
4
Q
Creating a trust - trust agreement
A
- A legal document that cleraly establishes how a trust’s assets should be managed and distributed, including in cases when the grantor dies or becomes incompetent
5
Q
simple vs complex trust
A
- Simple - distributes ALL INCOME annually
- Complex - allowed to accumulate income within trust
6
Q
Funding the trust
A
- This means that the grantor needs to change TITLE OF OWNERSHIP from their name to the name of the trust
- Pretty much any asset that is titled can be included in a trust
7
Q
Managing trust assets
A
- Done by a trustee who can be an entity or a person
- Are considered fiduciaries
- So they can be personally liable for any unreasonable losses within a trust
- Responsibilities include:
- Receiving and managing trust assets
- Distribiuting and collecting income
- Accounting and tax reporting
- Following provisions in trust document
8
Q
Types of trusts
A
- Living trusts
- Recovable OR irrevocable
- Testamentary trusts
- Recovable or irrevocable
9
Q
Living trusts
A
- Established while grantor is STILL ALIVE
- Sometimes called grantor trusts
- Must also have a will to distribute property not specifically owned by the trust.
10
Q
Testamentary trusts
A
- Establisihed THROUGH A WILL when grantor idies
- Trustee is named in the will
- Revocable until death or incapacity of grantor
11
Q
Revocable trust
A
- Grantor can amend, alter, or terminate trust without notice
- Grantors are usually also the trustee is these instances
- Becomes irrevocable at death of grantor and DOES NOT AVOID estate taxes
12
Q
Irrevocable trusts
A
- Grantor CANNOT alter, amend, or terminate trust
- The transfer of property to these trusts are considred a complete gift, and so gift taxes apply to these transfers
- However, once assets have been transferred, they WILL NOT be included in the grantor’s gross estate for tax purposes
13
Q
Consider these four things when selecting a trust
A
- Purpose of the trust
- What the trust can accomplish
- The features/characteristics of the trust (how it works)
- The tax situation for the grantors and beneficiaries
14
Q
Credit shelter trust
A
- Also known as bypass, family, and B trust
- Primary purpose is to shelter the deceased spouse’s avaialble credit against the estate tax
- Remember that there is an unlimited estate tax deduction for property left to a surviving spouse, but may not protect the property from estate tax when THE SURIVIVNG SPOUSE DIES (so that’s why we use this)
- Surviving spouse has LIMITED access to income from trust
- Trust is not required to distribute all income (complex trust)
- Helps surviving spouse avoid estate taxes as well
- Children can be bene’s of the trust and can receive income at the trustee’s discretion
- Surviving spouse HAS LIMITED POWER OF APPOINTMENT AND DOES NOT HAVE DIRECT CONTROL
15
Q
A trust
A
- Also called marital trust
- Can be part of a A-B arrangement
- Purpose of A trust is to give MORE DIRECT CONTROL of assets held in the A trust compared to those held in the B tust
- Assets are TAXABLE at death of the surviving spouse (because of the more control)
- Good for preserving decedant’s GST tax
16
Q
QTIP trust
A
- Qualified terminable interest property trust
- Also known a C-trust
- Allows a decedent to use martial deduction at death but STILL CONTROL ULTIMATE DISPOSITION OF THE ASSETS
- Mainly used in second-marriage situations, for remarried couples, families with remarriages, and families with stepchildren
- Decedant still controls disopoition of property even when dead and when surviving spouse dies, it goes to who they wanted it to go (usually children from first marriage)
- Surviving spouse receives LIFETIME INCOME (life estate)
17
Q
QTIP trust - process
A
- Decedant funds the trust and then at death, the exeuctor of the estate makes the QTIP election, which allows an estate tax marital deduction to avoid paying estate taxes
- Then, the survivng spouse is entitled to ALL INCOME in the trust for lifetime, and must be paid at least annually (required to receive)
- At the death of the surviving spouse, the assets transfer to the bene’s of the trust (the reaminder interest)
- REMEMBER THAT ASSETS ARE FULLY TAXABLE AT DEATH OF SURVIVING SPOUSE
18
Q
GST trust
A
- Also known as a dynasty trust
- Allows a grantor to transfer assets to beneficiaires who are at least two generations removed, such as grandchildren.
- If bene if NONRELATIVE, anyone who is 37.5 years younger than the grantor is considered two generations removed
19
Q
GST trust - Process
A
- Grantor funds trust with APPREICATING ASSETS or life insurance up to the GST exemption amount (applicable credit amount)
- Grantor’s children may receive income from the trust (middle generation)
- Not taxed on this until death of last GRANDCHILD
- Then, once the last child dies (the last child who receives the income), the assets transfer to the SKIPPED GENERATION (the grandchildren)
20
Q
Explain direct skips
A
- Can happen when someone from one generation (grandparents) passes assets to someone in a younger generation (grandchildren)
- Meaning that they skipped the MIDDLE generation (the grandparents’ children)
- Can occur through gifts or bequests
- After taking the annual exclusion, a taxpayer’s GST tax exemption is allocated FIRST to DIRECT skip transfers
21
Q
QPRT
A
- Qualified personal residence trust
- Purpose is to REMOVE the value of a personal residence OR vacation home from the estate of a client
- Very useful for when property values are INCREASING QUICKLY
22
Q
QPRT - Process
A
- Grantor transfers OWNERSHIP of home to an IRREVOCALBE TRUST
- Grantor retains the right to use and live in the property for a PREDETERMINED number of years
- The value of the transfer for gift tax purposes is determined using IRS tables
- At the end of the predetermined number of years, the property is transferred to the trust BENE TAX FREE, (can’t be the grantor)
- If the grantor outlives the term of the trust:
- The value of the property is EXCLUDED from the grantor’s gross estate
- If the grantor DIES before the term is up, the FMV of the home will be included in their gross estate
- If the grantor outlives the term of the trust:
23
Q
ILIT
A
Should have provision within the trust that final expenses and taxes of the decedent’s estate may be paid from trust proceeds
24
Q
Crummey trust
A
- Can be used to postpone the age of ownership while allowing the donor of the property to maintain control of the asset for the CHILD’S BENEFIT
- Usuallly funded with amounts equal to the annual gift tax exclusion
25
Crummey trust - Provision
* Crummey trusts MUST INCLUDE provision that allows the child a NON CUMULATIVE RIGHT to withdraw the annual contribution to the trust, restricted to the amount of annual exlusion OR the GREATER of 5k or 5% of the corpus
* Usually restricted to 30 days where the bene can withdraw
* Reason for this provision is it confers a PRESENT INTEREST in the trust so that the grantor can take annual exclusions to reduce taxable gifts to the trust
26
Special needs trust
* Sometimes called supplmenetal needs trust, is created to provide for the needs of a disabled child or adult
* They coordinate with disability and medical benefits the bene may receive from governmental sources
* Can be terminated or changed in order to ensure that the bene reamins eligilble for other benefits
27
Medicaid Disabilty Trusts
* Available ONLY to persons who are disabled and YOUNGER than age 65 and who qualify for public benefits
* A nonprofit organization manages the assets in the trust
* This is the ONLY TYPE of trust that is EXEMPT from rules regarding Medicaid eligilbity and trust use
* Medicaid can recover any remainining assets UPON TRUST TERMINATION
28
Blind trust
* Mostly used by politicians and others in poisitions of power who have real or perceived conflicts of interest
* Property from grantor is managed by an indepedent trustee, who manages the assets indepdnetly of the grantor
* It is revocable
29
Totten trust
Used to hold bank account assets for a client with a named beneficiary
Client retains full control over the account during the client's life and then no gift tax is imposed until after client's death (because it is revocable)
30
Spendthrift trust
* Prohibits bene from assinging his/her income or asset rights within the trust
* it ensures the bene will not imprudently use trust assets and it is effective in sheltering assets from creditors
31
Asset protection trust
* ONLY FOUR STATES allow this trust, which provides income to the grantor or other bene's but PROHIBITS the distribution of assets for the payment of creditor claims
* Can be perpetual (trust that last forever)
32
Standy trust
* An unfunded entity that becomes active ONLY WHEN AN EVENT OF A NAMED OCCURRENCE HAPPENS, such as disability or incapciatiion of the grantor
* Provides continuity of asset management in the even of the triggering event
33
2503b trust
* Held for minors and can be held for the bene's lifetime or period of years and ultimately passed to another bene
* All income must be distributed from the trust annually
* Portion of gifts is considered interest income (gift tax exlclusion) and remainder interest (no gift tax exclusion allowed)
34
2503c trust
* For children under age 21
* Bene must be given the right to withdraw income AND principal from the trust age AGE 21
* All gifts are subject to annual gift tax exclusion
35
Power of appointment
* This grants the bene of the trust the right to determine what happens to assets held in the trust
* It's usually limited, such as only using the income for health, edcuation, support, etc.
* Assets will NOT BE included in the power holder's gross estate
36
General power of appointment
* Does NOT have limited scope to what they can do with trust assets
* Will be included in gross estate becuse this holder of power would be considred the owner of the trust assets
37
5-and-5 provision
* If someone is holding a GENERAL power of appointment AND releases power OR fails to exercise this power, the IRS may determine that a gift has been made to the remainder beneficiary
* To avoid this:
* The 5 and 5 provision states that the trust beneficiary can take OR appoin the GREATER of 5k or 5% of trust assets on an ANNUAL BASIS to avoid the gfit tax
38
Perpetuities
* Some states have limit on duration of trusts to 21 years and 9 months BEYOND the point when any person was alive at the time of trust creation
* Trusts desinged to benefit charitable organizations are exempt
* Some states don't even have this rule
39
Discretionary provision
* Allows trustee COMPLETE DISCRETION in terms of distributing income and assets from a trust to a bene
40
Sprinkling provision
* For trusts with more than one bene, it allows the trustee to distribute income and assets from the trust to each bene in DIFFERENT PROPORTIONS
* Usually based on abilities, talents, and financial needs
41
Trust interests - Income bene
* CANNOT change or direct who ultimatley receives the trust assets
* So trust assets are NOT included in their estates
42
Trust interests - Remainder bene
* Receives trust assets AFTER trust income interests have ended
* Trust assets WILL BE INCLUDED in their gross estate
43
Taxation of revocable trusts
* Transfers from grantor are NOT a completed gift (not gift taxable)
* Transfer from trust to another person/entity is taxable gift over annual exclusion amount
* Gift tax paid by grantor
* Assets are included in grantor's gross estate
* Income taxed to grantor
44
Taxation of irrevocable trusts
* Transfers to trust by grantor is taxable gift
* Assets at grantor's death not included
* Except when assets are held in GENERAL power of appointment and grantor has right to change trust bene's or could distribute trust income
* Except in the life insurance rules
* Income is NOT taxed to grantor
45
Form 1041
* Income tax return for trusts (and estates) for income not distributed to beneficiaries
46
Trust income - 1041
* Must report all income earned by trust
* Eligible to reduce income with exemptions and deductions, such as expenses related to trust managmenet, charitable expenses, and interest paid.
* Also certain tax credits for trusts may apply
47
Penalties for trust income return
* Failure-to-file - same as personal income tax
* Failure to pay tax - 10% penalty
* All other penalties are same as personal income
48
Advantages of Charitable Trusts
* The transfer of assets to charities help avoid capital gains taxes on amounts transferred
* The donor can elect to receive income interest from the trust, based on the value of the assets it hold
* The donor can also receive a charitable income tax deduction EQUAL TO the FMV of the asset, LESS any income interest the donor may receive
49
CRAT
* Charitable remainder annuity trust
* Allows donor to make a charitable gift and receive income stream from it
* Pays out FIXED DOLLAR every year in an amount of AT LEAST 5% of the value of the trust
* Charity must receive AT LEAST 10% of the originial contribution at the death of the trust bene's OR a fixed term of 20 years
* Best used for LOW BASIS appreciated assets since no capital gains tax is used when the trust sells the stock
* Donor receives a charitable income tax deduction for the PV of the charity's remaiinder interest in the year the trust is funded
50
CRUT
* More fleixlbe than CRAT
* Same rules at CRAT EXCEUPT
* Guarantees payment of AT LEAST 5% payout
* Payout is based on actual value of assets in trust, not on the beginning value
* Income will fluctuate, which can be used as a hedge against inflation
51
CLT
* Charity receives income from trust for a predetermined amount of years
* Can be CLAT or CLUT
* At end of income period, assets held in the trust either:
* * Revert backto grantor OR
* Transferred to a named bene
* Assets transferred to a NONCHARITABLEE BENE are subject to gift tax
* When grantor retains reversionary interest in the trust:
* A charitable income tax deduction is available for PV of the income stream to charity
* With a NONGRANTOR CLT, grantor does NOt receive an immediate tax deduction
* Rather, the grantor's taxable income is reduced by transferring income to a charity
52
CLT - reversionary interest
* A CLT is generally established in a way that the donor retains a reversiioanry interest in the property while directing income from the trust to go to a charity for stated number of years
* At trust termination:
* Property is returned back to the donor or donor's bene's
* Donor receives income tax deduction in the year of the initial property transfer
53
Pooled-income fund
* Used very frequently by charitable organizations
* Provides income to a NUMBER of existing and future donors
* Each member of the pool receives income based on their proportional share of the assets in the account for life
* Charity receives assets AFTER death of donor or death of subsequent named bene
* Donor receives charitable tax deduction for the PV of the charity's remainder interst
* Donor can also make future contributions to receive a greater share of income and take additional charitable income tax deductions
54
Gift Annuity
* Donor transfers assets to a charity in return for a life or joint-and-survivor life annuity
* Resembles traditional insurance contract (pays fixed or variable)
* Donor receives tax deduction for the amount of transfer that EXCEEDS the actuarial basis of the annuity
55
Donor-advised fund
* Rather than transfer assets directly to a charity, client can establish a charitable fund trhough an investmetn firm
* Donor will receive tax deduction when established
* Donor retains right to manage fund assets and determine what charitable organization will receive grant from the fund
56
Bargain sale
* Selling property to a charity for less than its FMV
* Value of gift, for tax purposes = FMV - selling price
